IMAGINE that the world’s best specialists in a particular disease have convened to study a serious and intractable case. They offer competing diagnoses and treatments. Yet preying on their minds is a discomfiting fact: nothing they have done has worked, and they don’t know why. That sums up the atmosphere at the annual economic symposium in Jackson Hole, Wyoming, convened by the Federal Reserve Bank of Kansas City and attended by central bankers and economists from around the world*. Near the end Donald Kohn, who retired in 2010 after 40 years with the Fed, asked: “What’s holding the economy back [despite] such accommodative monetary policy for so long?” There was no lack of theories. But, as Mr Kohn admitted, none is entirely satisfying.

I’d like to solve the mystery that perplexed the greatest minds of monetary economics. Money has been ultra-tight since mid-2008.

The real mystery of Jackson Hole is why the greatest minds in monetary economics fail to recognize this fact. Milton Friedman understood. Ben Bernanke explained in 2003 that neither interest rates nor the money supply were reliable policy indicators, and ultimately only NGDP growth and inflation could tell you whether money was easy or tight. By those indicators (averaged) money’s the tightest since Herbert Hoover administration.

I’d like to offer a conjecture. If the monetary economists understood that monetary policy since mid-2008 had been ultra-tight, they would have a very different view as to what sort of policy is appropriate today.

Lots of economists have offered rebuttals to the market monetarist claim that easier money would help right now. For instance, George Selgin and Eli Dourado offered critiques of the sticky wage explanation for persistently high unemployment. But I’ve yet to see a single economist take on my claim that money’s been very tight. I don’t expect economists to take what I say all that seriously, but I do expect them to notice when Bernanke blatantly contradicts his 2003 definition of the stance of monetary policy, with no justification provided. This issue is far more important than whether his recent policy is inconsistent with his advice to Japan, and yet he has not been asked about the contradiction. Even worse, almost all economists accept the definition offered by the political Bernanke, not the academic Bernanke. Which do you think more likely represents his actual views?

PS. Some commenters asked me about the Dourado post. I addressed the plausibility of sticky wages here, and in numerous other posts in reply to Tyler Cowen and George Selgin. I’d also point out that there is lots of cutting-edge research that tells us that the “common sense” approach to the wage stickiness hypothesis is not reliable. By common sense I mean; “Come on, wouldn’t the unemployed have cut their wage demands by now.” Yes, they would have, but that doesn’t solve the problem. This is partly (but not exclusively) for reasons discussed in this recent Ryan Avent post.

Keynesian economics works only if, as more money is created equivalent amount of energy can be created. This worked fine till the oil was easy to find. Now that we have passed peak oil Keynesian economics do not work any more. This is what is happening.

Economics who are unaware that “life is manifestation of energy” – means all life forms need energy to sustain will be clueless…..

Over the course of the next 2-3 years, money will suddenly become mysteriously tight in quite a few countries. It will continue to be tight in Japan and Switzerland, and it will become suddenly tight in Australia, Canada & Norway.

Ie each dollar buys more and better stuff — ie the dollars is takes to receive more and better stuff is falling, ie the price for stuff is falling, even if the supply of money had stayed stable — which it hasn’t.

A fixed and stable stock of money is all the money you ever need — such money is neither ‘lose’ nor ‘tight’.

How do you say that money is ultra tight, NGDP (your measure of Fed Accomidtation) is 4.5% ~ only 1/2 percent behind ideal. You can say that money was ultra tight, and that triggered a recession (but by your method of measurement that is practiaclly tautology), but you can’t say money is extremely tight.

JerryC,

I agree with you that the availablity of credit is what drives economic cycles. Monitary economic almost hits the point. The money suply is nearly the credit supply.

Damn it Greg, you’re just not getting it are you? The art of political strategy is to introduce a COMPLETELY ARBITRARY STANDARD and then engage in perpetual quack ex post justifications for it.

According to this arbitrary standard, yes, money has been super duper ultra mega ultimate tighter than a nun on Sunday using a Hoover vacuum tight.

See, the beauty of political strategizing is that if guns and SWAT teams can succeed in bringing about a particular history, say enforcing a monetary system that resulted in 5% NGDP growth on average, then BAM, the strategists now have a status quo fallacy to fall back on. No matter what criticism is made, the historicist minded can always say “We’re just advocating for a conservative prolongation of what already took place, because it worked pretty well over that time.”

Then they feel immunized.

If you still poke and prod them, they will invoke the ethic of “pragmatism”, and say that it is pragmatic that the status quo continue, since, well, it is the status quo!

There is no critique of the status quo, and in MM’s case the status quo is 1980-2007. There is a jealous defending of this period against all criticisms, because that is their baby. Anyone who dares criticize this period as having non-market money production, and hence non-market NGDP growth, they’re branded as ideologues and radical extremists.

Milton Friedman in his later life advocated for a computer to grow the money supply at a fixed rate, and then later than that he advocated for the Fed to be abolished. Why Sumner would feel compelled to whoring Friedman out for his own particular agenda, as if Friedman did not hold his own views, but Sumner’s views, is probably due to the fact that MM is theoretically weak, and needs all the appeals to authority it can get, even if the authority in question doesn’t actually share the same views.

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Lower wage rates solves the problem of unemployment. This represents an embarrassment to those who advocate for accelerated inflation using sticky wages as a justification. So as expected we see more ex post justifications for NGDP targeting, this time the claim is that even if there is full employment, there are still problems associated with insufficient AD.

Ryan Avent’s article just denies the context of falling wage rates. He critiques the ability of falling wage rates to eliminate unemployment, not by analyzing what happens when wage rates fall the clearing level given a demand for labor, but what happens when employers won’t hire new workers unless they experience a rise in demand. Avent doesn’t seem to grasp the fact that this thought experiment is in fact a denial of wage rates falling sufficiently. By saying firms won’t hire more workers unless demand rises, he is actually presenting a scenario where he is holding wage rates fixed.

The proper way to understand how a fall in wage rates can eliminate unemployment is by actually considering falling wage rates. If a firm has a given nominal demand for its produces, then in principle it could hire any quantity of workers, even with fixed nominal demand for labor, provided of course that as more workers are hired, their individual wage rates are that much lower. It would be like the difference between hiring 100 people at minimum wage, or 200 workers at half the minimum wage. The same demand for labor can buy more labor. The demand for products does not even need to rise!

Like I said yesterday, MM and the inflationist political strategists in general, are desperately plucking at every possible ex post justification to present more inflation as the only cure. Maybe it takes an outsider to notice that it represents a pathology.

Doug M, you fool! If we start recognizing that NGDP has been growing at 4-5% annually since 2010, then sooner or later we are going to have to accept that 4-5% NGDP is not associated with full employment!

That is why we must continually repeat the following phrase:

“Milton Friedman and Ben Bernanke agree with me that the proper gauge of monetary policy is NGDP, and NGDP growth has been the lowest since the Hoover administration (nod nod wink wink about the true cause of the Great Depression).”

Repeat that over and over again, and secretly hope that unemployment remains somewhat high, because if we start to advocate for less and less of a “catch up” as time goes on, and this waiting time standard is completely and totally arbitrary of course, just like the rest of MM, then we’ll pass “1/3 catch up”, then “1/4 catch up”, then “1/5 catch up”…then we’ll pass the dreaded “I give up, no catch up” phase.

Once THAT is passed, once NGDP growth continues to grow for so many years with persistent high unemployment that no amount of arbitrary subjective judgments of waiting times will pass the political test, then maybe, just maybe, MMs will become economists and start analyzing the market using something other than their Keynesian inspired AD goggles. Yet I wonder if they they can even do that, considering how they have not displayed this as of yet.

It’s worth keeping in mind that the present context is one in which the mere absence of continued increases in nominal wage demands, rather than actual nominal wage cuts, ought to have sufficed by now to have eliminated unemployment stemming from slack demand. So the question isn’t exactly, “How can nominal wages be so sticky?” It is, “How can inflation expectations, or whatever it is that has been tending to drives money wage demands up, be so sticky?” The second question is (I should think) a lot harder to answer than the first.

Scott, did you read any of the papers from the conference that the Economist article links to (besides Woodford)? And what did you think of the article’s remarks on the “redistributive effects” of monetary policy?

It seems to me like a bit of a tautological definition under which you never come to the conclusion that there is something fundamentally wrong with the economy because it can not survive without loose money. The unusually loose money is always defined as the new normal, the new “tight”.

The real problems that cause the need for tight money, excessive private debt (gee, a result of past loose policy), foreign currency manipulation and domestic income inequality, remain dogmatically unaddressed.

“MBS purchases will continue until we see a better employment situation,” Lockhart said today in a speech in Atlanta. “If we do not see improvement, more action may be taken. And inflation will be monitored closely and kept near 2 percent.”

…

“My comment on that is 5.5 percent is much closer to current measures of full employment,” Lockhart said. “I am not so sure that it will not be appropriate to begin the process of tightening before we would get to what we would consider full employment. I don’t want to rule out that could be the case.”

Context. After the depth of this downturn NGDP should have rebounded much more robustly.

See that? Even if NGDP has been rising 4-5% since 2010, we are presented with the excuse of an undefined “context”, which of course is a defense against criticisms that unemployment is still persistently high despite NGDP having consistently grown for years.

Is this excuse going to be used forever? We’re in the year 2026, and we’re still being told “Stop blaming us for the high unemployment. That downturn of 2008 was really big! If the Fed didn’t let NGDP fall, we would not be in this mess. Context context context people!”

“So the question isn’t exactly, “How can nominal wages be so sticky?” It is, “How can inflation expectations, or whatever it is that has been tending to drives money wage demands up, be so sticky?” The second question is (I should think) a lot harder to answer than the first.”

Whatever the relative difficulties of these questions happen to be, the second question can be answered by answering a third question, which is “What are the means being used by the millions of unemployed people to sustain themselves despite having zero wage income, for years on end?”

I think the second question becomes a lot easier to answer in this way.

So, context matters. We should target 2013 NGDP but some 5 year historical average? What is the lookback? If 5% is too slow (despite the fact that the number is hammered over and over again in the blog), what level 2013 NGDP should the fed target?

Money can be tight because of a loss of safe collateral. This forces up the price (down the yield) of the remaining safe collateral. At the same time traders are forced to use more money-like instruments (more liquid ones with higher opportunity costs) in place of the lost ones. Broad money becomes tight. Something like $5 trillion of formerly AAA low information cost collateral has been downgraded.

This resulted in decreased lending.

At the same time, European banks need to raise capital to meet the Basel III requirements. Since nobody wants to buy European bank stock, they have to reduce their assets at risk (like loans). The ECB has pumped money into the banks, but they aren’t lending it.

So It’s not just NGDP that tells you money is tight.

The article on sticky wages is interesting, and says some things I’ve been saying, but it has better evidence and additional conclusions, so I may be a bit biased.

I would add that IPOs are near 0 and the number of listed companies has been in continuous decline since before 2000.
Job growth comes from small companies hiring as they get bigger, not from static companies large or small. These jobs also tend to be better paying jobs.

All the lost jobs paying around $14 or below have been replaced and most of those over $30. All the net shortfall is in the jobs in the middle.

Your list is missing a huge category: voluntary actions and associations of individuals: charitable institutions from churches, to non-profits such as The Salvation Army, Harvesters, food banks, United Way, and personal extensions of charity…America is one of the easiest places to not starve if you don’t want to. Many organizations provide more than food, they provide shelter, clothing, school supplies, scholarships.

I addressed the plausibility of sticky wages here, and in numerous other posts…

I don’t understand why the “sticky wages” issue is so hard to understand. We have obvious examples of it in action all around us.

Take a labor union whose members are asked to vote on the proposition: “To save all our jobs we can all take a 5% pay cut, or else we can keep all our pay and just lay off the 5% most junior of us.” This happens all the time — and the vote is near always “We keep our pay, goodbye to you junior 5%” by a typical vote of 95-5.

The union mechanism makes it more visible to the naked eye, but the same incentives and pressures exist in non-union work forces.

Try to force an across-the-board pay cut on a non-union workforce and morale will be hammered, and the *first* employees to bolt to the competition or to other opportunities will be your *best* employees, among many other unhappy consequences.

Well, why not just hammer down the wages of new hires?

Because then you are paying people widely different amounts for the same work of the same quality, and *nobody* likes that, the results are toxic to everybody. (Unions fight that tooth-and-nail too, but again the same processes work everywhere.)

Tell people publicly to their faces: “Yes, you are doing the same job, but I am paying you all very differently. You guys here are getting *30% less* — even if you do better work than those guys getting more! — for no reason other than that’s all I’m going to pay you, tough, lump it, deal with it.”

You will be lucky if they deal with it by quitting and badmouthing you and your business to everyone they know — because if they stay on the results will be toxic among *both* the high-paid and low-paid workers.

Businesses do what is best for them. And a work force that feels it is being treated fairly is a *hell of a lot* better for it than a work force that is insecure, feels it is being screwed and fears a totally uncertain future due to the arbitrariness of the bosses, but is 5% larger.

Jim, why would a business pay people 30% more to people for doing the same quality of work? That’s not how the free market works at all. Your scenario is where union coercion exists. As someone who has employed people, I would get rid of the ones who were 30% more expensive doing the same work. They obviously aren’t worth it. That’s how a free market works.

Jim, why would a business pay people 30% more to people for doing the same quality of work? That’s not how the free market works at all. Your scenario is where union coercion exists. As someone who has employed people, I would get rid of the ones who were 30% more expensive doing the same work. They obviously aren’t worth it. And I can then reduce my costs and increase my profitability. That’s how a free market works.

George, You can say that wage cuts ought to have eliminated unemployment, but the fact is that wages are stickier than they seem, and hence they have not fallen enough to have eliminated unemployment. The demand shock was unusually severe, and wage growth hasn’t slowed enough to offset that shock.

Saturos, I didn’t read the other papers. I don’t think monetary policy has important redistributive effects, unless policy is way more expansionary or contractionary than expected. Certain a 5% NGDP target, a 2% inflation target, or any other plausible target would not have important distributive consequences. The key issue is jobs.

I actually agree with Lockhart–Kocherlakota’s proposal might (and I emphasize might) end up being too expansionary.

@Jim Glass: excellent examples of wage stickiness. I’ve seen the same here locally (in California), with a public school teacher’s union. The district was in fact well-funded, and did deficit spending for a couple of years — along with 0% wage increases — to try to ride out the storm until the economy returned to normal.

But last year, their reserves were finally running out, and they finally did budget cuts and layoffs. And just as you suggest, the union voted for laying off the least-senior 5%, rather than issue a 5% across-the-board pay cut. (And that’s a rational vote, on the part of each union member.) Teacher wages have not fallen one bit during this recession. (In fact, there are still contract-mandated “step and column” wage increases due to increased senority over time.) The school year just started; so in fact, it has only been in the last month that the consequences of 2008 have finally played out in this particular district.

@Razer: you have a working company with 100 employees, and suddenly discover that all are being paid 30% above current market value. It’s just not feasible to fire 100% of your employees, and hire an entire brand new team at the new lower wages.

The way this actually happens, is that a new company starts, with all new (much cheaper) hires, and eventually the old company has too high a labor cost basis, and goes out of business.

But company-level changes in market dominance, is not the kind of thing that completes in just a few short years.

Scott, I didn’t mean to deny that something may indeed have gone badly wrong with wage adjustment; I merely wished to say that it is more than mere lack of cuts: it is a very surprising degree of inertia in wage rate increases. I’m not inclined to insist that it must not be happening–just that if it’s real, it is very different from the sort of stickiness that was present in the 30s.

Companies are succeeding at reducing their payroll costs. Why do they have to do it by cutting wages, when their way seems to be working for them?

And how do you know they aren’t. You need to look at the distribution, not just the mean wage. It looks like the distribution is going bimodal. The average wage happens to be in the middle third of the income distribution – the third that isn’t being rehired. If what’s being reported is the average of high and low, the implications are different. The averaging $35+ per hour and $14- per hour gives you the $25 just as well as a normal distribution would.

Almost the entire shortfall is in the middle third. In fact the bottom third is already over 100% recovered. It’s hard to have a strong recovery in a consumer economy when most of the jobs you’re creating provide very little discretionary income.

George, I agree that it’s different from the 1930s. I’ve argued that there is a sort of (informal) zero lower bound on wage increases. Nominal wage cuts do occur, but rarely. This means the average wage increase will bottom out above zero, reflecting a mixture of healthy industries getting 4% raises, and depressed industries getting zero percent increases.

Peter, You said;

“Companies are succeeding at reducing their payroll costs. Why do they have to do it by cutting wages, when their way seems to be working for them?”

Yes. But here it seems that we are entering the fuzzy zone in which cyclical (demand-based) unemployment gives way to the structural sort, where the problem may be understood as one of misallocation of labor rather than deficient aggregate demand. Please note that “fuzzy” and that “may be.” I readily confess that I am not at all sure where the fine line is.

“How do you say that money is ultra tight, NGDP (your measure of Fed Accomidtation) is 4.5% ~ only 1/2 percent behind ideal.”

I think it’s helpful to think of it this way. Imagine a nation was on the gold standard at $100 an ounce. Suddenly, they went off it and gold dropped to $91 an ounce, then settled at $85 an ounce 4 years later. Anyone advocating returning to the gold standard would have to decide what price to return to. Some would say the previous $100, some $85, some in between (I assume few if any would advocate ouside that range).

During the Great Moderation, NGDP grew at a trend of about 5%. Not exactly 5% per year, but when it deviated, there was a return to path. Those of us who like prosperity more than ideology want to return to that. Since we’re something like 15% below that level, should we stay 15% below permanently, make up the entire 15%, or pick a number in the middle?

The correct answer is the more time goes by, and the more contracts are negotiated in good faith at the new level, the less make up you need. Once 100% of contracts are after the drop, there should be no make up.

I am a bit young to remember how we did things when we were on the gold standard. However, I am familliar with currences that are on a managed float.

A managed float currency is pegged at to the price or a reseve currency and allowed to float minimally around the price of the reseve curency. If the price approaces the bands the central bank intervenes to keep the price in the band. If a shock pushes the currency outside of the band, the central bank doesn’t try to get back in the band, it redifines the band to one that it can defend.

We are out of the band. It is time to forget the trendline from 1985 to 2005, and start looking at a new one from 2010 to present.

For the record, I also was born after we left the gold standard – my knowledge of the gold standard is from reading history, not from personal memory.

I agree with you that we are out of the band, and need to redefine the band in terms of NGDP. I don’t agree that we should start a new band from where we are. We should move at least part of the way back to trend. I suspect that most credit contracts, including mortgage and labor contracts, were entered into before the shock of 2008, not after. That suggests to me we should move more than halfway back to the pre-crisis trend and establish the new trend from there.

If we don’t do that, I fear we only have two realistic alternatives for pre 2008 mortgages – mass foreclosure, or mass cramdowns. Once we get through that mess, we could start a trend based on where we are now.

I don’t think monetary policy has important redistributive effects, unless policy is way more expansionary or contractionary than expected. Certain a 5% NGDP target, a 2% inflation target, or any other plausible target would not have important distributive consequences. The key issue is jobs.

Over 20 years, a constant cash infusion into primary dealer bank accounts that is used to target NGDP can have the outcome of large ownership inequality.

It’s easy to look at only one year’s worth of inflation and say it’s not much, but you have to remember that the Fed is sending new dollars to the same general group of institutions year after year.

So it is better to consider 1.05^20 = 2.65, and then ask what share of that NGDP factor went to the banking system and military industrial congressional complex elite, and what share went to the cliche widowers and orphans who live off fixed incomes and charity.

If we look at real wages, since 1971, we find that real wages have stagnated. Yet real growth in the aggregate has increased. What does that tell you about which economic role types the share of the NGDP factor has primarily went to?

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You say the key issue is jobs, but a while ago you said that if you can get 5% NGDP targeting, then you wouldn’t care if half the country becomes unemployed.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.